March 7, 2019 / 3:26 PM / 9 months ago

Euro sovereign bond rush may be more warning than win

LONDON (Reuters) - This year’s storming demand for new euro zone government bonds may reflect investor resignation to the prospect of many years of slow growth to come rather than a vote of confidence in the bloc’s economy.

The European Central Bank appeared to confirm those fears on Thursday as it slashed growth forecasts and pushed out the timing of its first post-crisis rate hike until 2020 at the earliest. It also offered banks a new round of cheap loans to help revive the economy.

Belgium, France, Italy and Spain have all drawn record demand for long-dated bond sales in recent weeks, while this week saw former debt market pariah Greece swamped with orders for its first 10-year bond since 2010.

Euro zone countries sold a total 35 billion euros of debt with maturities of 15 years or more through syndications between Jan. 1 and Feb. 25, up from 24 billion euros raised in the same period last year, according to Refinitiv data. That figure doesn’t include Spain’s 5 billion euro 15-year deal which came a day after the data was calculated.

Issuance across all bond maturities is also higher this year — at 80 billion euros versus 68 billion euros in the same period of 2018 — even though the coupons and yields being offered are significantly lower.

EUROPE = JAPAN

Cheaper borrowing costs and strong investor demand are generally good news. But some market watchers, such as Charles St-Arnaud, senior investment strategist at Lombard Odier Asset Management, say they could indicate that investors believe “Europe is now Japan”.

Of course, demand for safe assets has been high for lots of reasons — global politics, a lackluster outlook for world trade and growth, and an aging population that spurs pension funds to buy more bonds.

But reflecting on France’s 7 billion euro 30-year bond sale last month, St-Arnaud said investors’ willingness to accept a 1.6 percent yield implies they have taken meaningful economic growth and inflation out of the euro zone picture for the next three decades.

That’s a scenario which bears a remarkable resemblance to Japan’s “lost decade”, he said, referring to a period of economic stagnation than began in the 1990s.

Long-standing predictions that Europe could tread a similar path — deflation, a shrinking population, high debt and weak growth despite endless stimulus — were somewhat muted while the ECB’s bond-buying and cheap loan schemes helped lift growth.

But now, with the 2.6 trillion stimulus scheme at an end, an economy said to be slowly returning to normal and an interest rate rise still possible early next year, one would expect investors to see bonds as a mixed investment at best.

The fact that isn’t happening means “Japanification” is more of a threat than people thought this time last year.

“In late 2016 and 2017, it felt like we were breaking out of that cycle but the reality is we seem to be going back to that Japan-like environment of low growth, low inflation and accommodative central banks,” said Iain Stealey, a portfolio manager at JP Morgan Asset Management.

He said those factors make JPM AM, one of the biggest funds in the world with over $1.71 trillion of assets, comfortable owning duration, a term used to usually describe government bonds of 10 years’ maturity and longer.

Willingness to take long duration bets indicates investors are confident long-term yields will not rise in this period as growth disappoints.

OFF-TARGET

ING’s “Japanification” model — which takes into account factors such as growth, inflation, interest rates and demographics — suggests that over the last couple of years, the euro zone economy has shown symptoms of this malaise. 

(GRAPHIC: ING's Japanification model shows European parallel - tmsnrt.rs/2VL5ikn)

Economists at the bank believe Europe is “Japanised” to some extent, saying in a research note that despite efforts by euro zone policymakers, the structural similarities remain striking.

German Bunds and even U.S. Treasury bonds are displaying a similar pattern of movement to what happened in Japan from 1998 onwards.

German 10-year yields have gone from 0.60 percent in October last year to around 0.12 percent currently and may even dip back into negative territory, according to some.

Then there’s inflation. Despite all the money the ECB has thrown at bringing up euro zone inflation towards its near-2-percent target, its favored market inflation gauge, the five-year, five-year forward, languishes at 1.51 percent, close to its lowest since October 2016. The rate, which measures where investors see inflation over a five-year period starting five years from today, suggests they do not expect inflation to hit the target for years to come.

Reporting by Abhinav Ramnarayan and Julien Ponthus; Additional reporting by Dhara Ranasinghe; Editing by Sujata Rao and Catherine Evans

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